financial accounting and accounting standards · 2015. 9. 6. · 13-4 . lo 1 indicate the...

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Chapter 13 Statement of Cash Flows Learning Objectives After studying this chapter, you should be able to:

1. Indicate the usefulness of the statement of cash flows.

2. Distinguish among operating, investing, and financing activities.

3. Prepare a statement of cash flows using the indirect method.

4. Analyze the statement of cash flows.

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Preview of Chapter 13

Financial Accounting IFRS Second Edition

Weygandt Kimmel Kieso

13-4 LO 1 Indicate the usefulness of the statement of cash flows.

Provides information to help assess:

1. Entity’s ability to generate future cash flows.

2. Entity’s ability to pay dividends and meet obligations.

3. Reasons for difference between net income and net cash provided (used) by operating activities.

4. Cash investing and financing transactions during the period.

Usefulness of the Statement of Cash Flows

Usefulness and Format

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Classification of Cash Flows

LO 2 Distinguish among operating, investing, and financing activities.

Income Statement Items

Operating Activities

Changes in Investments and

Non-Current Asset

Investing Activities

Changes in Non-Current

Liabilities and Equity

Financing Activities


13-6 LO 2 Distinguish among operating, investing, and financing activities.


Classification of Cash Flows Illustration 13-1 Typical receipt and payment classifications



Classification of Cash Flows Illustration 13-1 Typical receipt and payment classifications

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1. Direct issuance of ordinary shares to purchase assets.

2. Conversion of bonds into ordinary shares.

3. Direct issuance of debt to purchase assets.

4. Exchanges of plant assets.

Companies report non-cash activities in either a

separate note or

supplementary schedule to the financial statements.


Significant Non-Cash Activities


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Order of Presentation:

1. Operating activities.

2. Investing activities.

3. Financing activities.

Direct Method

Indirect Method


Format of the Statement of Cash Flows



Illustration 13-3

Format of the Statement of Cash Flows

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Illustration: Classify each of these transactions by type of cash flow activity.


1. Issued 100,000 shares of HK$50 par value ordinary shares for HK$800,000 cash.

2. Borrowed HK$2,000,000 from Castle Bank, signing a 5-year note bearing 8% interest.

3. Purchased two semi-trailer trucks for HK$1,700,000 cash.

4. Paid employees HK$120,000 for salaries and wages.

5. Collected HK$200,000 cash for services provided.

Financing

Financing

Investing

Operating

Operating

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Three Sources of Information:

1. Comparative statements of financial position

2. Current income statement

3. Additional information

Preparing the Statement of Cash Flows



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Three Major Steps: Illustration 13-4




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Three Major Steps: Illustration 13-4

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Indirect and Direct Methods



Companies favor the indirect method for two reasons:

1. Easier and less costly to prepare, and

2. Focuses on the differences between net income and net cash flow from operating activities.

13-17 LO 3 Prepare a statement of cash flows using the indirect method.

Illustration – Indirect Method Illustration 13-5



Illustration 13-5


13-19 LO 3

Additional information for 2014: 1. Depreciation expense was comprised of €6,000 for building and €3,000 for equipment. 2. The company sold equipment with a book value of €7,000 (cost €8,000, less

accumulated depreciation €1,000) for €4,000 cash. 3. Issued €110,000 of long-term bonds in direct exchange for land. 4. A building costing €120,000 was purchased for cash. Equipment costing €25,000 was

also purchased for cash. 5. Issued ordinary shares for €20,000 cash. 6. The company declared and paid a €29,000 cash dividend.


Illustration 13-5

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Step 1: Operating Activities Determine net cash provided/used by operating activities by converting net income from accrual basis to cash basis.

LO 3 Prepare a statement of cash flows using the indirect method.

Common adjustments to Net Income (Loss):

Add back non-cash expenses (depreciation, amortization, or depletion expense).

Deduct gains and add losses.

Changes in non-cash current asset and current liability accounts.


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Which is an example of a cash flow from an operating activity?

a. Payment of cash to lenders for interest.

b. Receipt of cash from the sale of ordinary shares.

c. Payment of cash dividends to the company’s shareholders.

d. None of the above.

Question


Step 1: Operating Activities

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Depreciation Expense Although depreciation expense reduces net income, it does not reduce cash. The company must add it back to net income.


Cash flows from operating activities:Net income € 145,000Adjustments to reconcile net income to net cash

provided by operating activities:Depreciation expense 9,000

Net cash provided by operating activities € 154,000

Illustration 13-7


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Loss on Disposal of Plant Assets Companies should report cash received from the sale (disposal) of plant assets in the investing activities section. Because of this,

any loss on sale is added to net income in the operating section.

any gain on sale is deducted from net income in the operating section.





provided by operating activities:Depreciation expense 9,000 Loss on disposal of plant assets 3,000


Illustration 13-8


Loss on Disposal of Plant Assets

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Changes to Non-Cash Current Asset Accounts When the Accounts Receivable balance decreases, cash receipts are higher than revenue earned under the accrual basis.


Company adds to net income the amount of the decrease in accounts receivable.

Accounts Receivable

1/1/014 Balance 30,000 Sales revenue 507,000

Receipts from customers 517,000

12/31/14 Balance 20,000

Illustration 13-9




provided by operating activities:Depreciation expense 9,000 Loss on disposal of plant assets 3,000 Decrease in accounts receivable 10,000


Illustration 13-10


Changes to Non-Cash Current Asset Accounts

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When the Inventory balance increases, the cost of merchandise purchased exceeds the cost of goods sold.



Inventory

1/1/14 Balance 10,000 Purchases 155,000

Cost of goods sold 150,000

12/31/14 Balance 15,000

Cost of goods sold does not reflect cash payments made for merchandise. The company deducts from net income this inventory increase.




provided by operating activities:Depreciation expense 9,000 Loss on disposal of plant assets 3,000 Decrease in accounts receivable 10,000 Increase in inventory (5,000)



Illustration 13-10


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When the Prepaid Expense balance increases, cash paid for expenses is higher than expenses reported on an accrual basis. The company deducts the decrease from net income to arrive at net cash provided by operating activities.

If prepaid expenses decrease, reported expenses are higher than the expenses paid.






provided by operating activities:Depreciation expense 9,000 Loss on disposal of plant assets 3,000 Decrease in accounts receivable 10,000 Increase in inventory (5,000) Increase in prepaid expenses (4,000)



Illustration 13-10


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Changes to Non-Cash Current Liability Accounts When Accounts Payable increases, the company received more in goods than it actually paid for. The increase is added to net income to determine net cash provided by operating activities.

When Income Taxes Payable decreases, the income tax expense reported on the income statement was less than the amount of taxes paid during the period. The decrease is subtracted from net income to determine net cash provided by operating activities.



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provided by operating activities:Depreciation expense 9,000 Loss on disposal of plant assets 3,000 Decrease in accounts receivable 10,000 Increase in inventory (5,000) Increase in prepaid expenses (4,000) Increase in accounts payable 16,000 Decrease in income taxes payable (2,000)


Illustration 13-11

LO 3


Changes to Non-Cash Current Liability Accounts

13-33 LO 3

Illustration 13-12

Summary of Conversion to Net Cash Provided by Operating Activities—Indirect Method


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Company purchased land of €110,000 by issuing long-term bonds. This is a significant non-cash investing and financing activity that merits disclosure in a separate schedule.


Land

1/1/14 Balance 20,000 Issued bonds 110,000

12/31/14 Balance 130,000

Bonds Payable

1/1/14 Balance 20,000 For land 110,000 12/31/14 Balance 130,000

Step 2: Investing and Financing Activities

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Net cash provided by operating activities 172,000 Cash flows from investing activities:

Purchase of building (120,000) Purchase of equipment (25,000) Disposal of plant assets 4,000

Net cash used by investing activities (141,000) Cash flows from financing activities:

Issuance of ordinary shares 20,000 Payment of cash dividends (29,000)

Net cash used by financing activities (9,000) Net increase in cash 22,000 Cash at beginning of period 33,000 Cash at end of period € 55,000

Disclosure: Issuance of bonds to purchase land € 110,000

Illustration 13-14 Partial statement

LO 3


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From the additional information, the company acquired an office building for €120,000 cash. This is a cash outflow reported in the investing section.


1/1/14 Balance 40,000 Office building 120,000

12/31/14 Balance 160,000

Building


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LO 3



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The additional information explains that the equipment increase resulted from two transactions: (1) a purchase of equipment of €25,000, and (2) the sale for €4,000 of equipment costing €8,000.


1/1/14 Balance 10,000 Purchase 25,000

12/31/14 Balance 27,000

Cost of equipment sold 8,000

Cash 4,000 Accumulated depreciation 1,000 Loss on disposal of plant assets 3,000 Equipment 8,000

Journal Entry

Equipment


Illustration 13-12

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Cash flows from operating activities:Net income € 145,000

Adjustments to reconcile net income to net cashprovided by operating activities:

Depreciation expense 9,000 Loss on disposal of plant assets 3,000 Decrease in accounts receivable 10,000 Increase in inventory (5,000) Increase in prepaid expenses (4,000) Increase in accounts payable 16,000 Decrease in income taxes payable (2,000)






LO 3

Statement of Cash Flows

Illustration 13-14

Indirect Method

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The increase in ordinary shares resulted from the issuance of new shares.


1/1/14 Balance 50,000 Shares sold 20,000

12/31/14 Balance 70,000

Share Capital - Ordinary


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LO 3


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Retained earnings increased €116,000 during the year. This increase can be explained by two factors: (1) Net income of €145,000 increased retained earnings, and (2) Dividends of €29,000 decreased retained earnings.


1/1/14 Balance 48,000 Net income 145,000

12/31/14 Balance 164,000

Dividends 29,000

Retained Earnings


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Which is an example of a cash flow from an investing activity?

a. Receipt of cash from the issuance of bonds payable.

b. Payment of cash to repurchase ordinary shares.

c. Receipt of cash from the sale of equipment.

d. Payment of cash to suppliers for inventory.

Question



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Cash flows from operating activities:Net income € 145,000

Adjustments to reconcile net income to net cashprovided by operating activities:

Depreciation expense 9,000 Loss on disposal of plant assets 3,000 Decrease in accounts receivable 10,000 Increase in inventory (5,000) Increase in prepaid expenses (4,000) Increase in accounts payable 16,000 Decrease in income taxes payable (2,000)






Illustration 13-14

LO 3

Indirect Method

Statement of Cash Flows

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Illustration 13-5

Compare The Net Change In Cash On The Statement Of Cash Flows With The Change In The Cash Account Reported On The Statement Of Financial Positions To Make Sure The Amounts Agree.


Step 3: Net Change in Cash

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Free Cash Flow

Free cash flow describes the cash remaining from operations after adjustment for capital expenditures and dividends.

LO 4 Analyze the statement of cash flows.

Illustration 13-15

Using Cash Flows to Evaluate a Company

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€4,189

Illustration 13-16

Less: Expenditures on property and equipment 1,794

Dividends paid 2,088 €307

Illustration

Required: Calculate free cash flow.

Using Cash Flows to Evaluate a Company

LO 4 Analyze the statement of cash flows.

Cash provided by operating activities

Free cash flow

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Using a Worksheet to Prepare the Statement of Cash Flows-Indirect Method

Illustration 13A-1

LO 5

APPENDIX 13A USING A WORKSHEET – INDIRECT METHOD

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1. Enter in the statement of financial position accounts section the statement of financial position accounts and their beginning and ending balances.

2. Enter in the reconciling columns of the worksheet the data that explain the changes in the statement of financial position accounts other than cash and their effects on the statement of cash flows.

3. Enter on the cash line and at the bottom of the worksheet the increase or decrease in cash. This entry should enable the totals of the reconciling columns to be in agreement.

LO 5 Explain how to use a worksheet to prepare the statement of cash flows using the indirect method.

Preparing a Worksheet

APPENDIX 13A USING A WORKSHEET – INDIRECT METHOD

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Using a Worksheet to Prepare the Statement of Cash Flows-Indirect Method

Illustration 13A-3 Completed worksheet— indirect method

LO 5

APPENDIX 13A

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1. Compute net cash provided by operating activities by adjusting each item in the income statement from the accrual basis to the cash basis.

2. Companies report only major classes of operating cash receipts and cash payments.

3. For these major classes, the difference between cash receipts and cash payments is the net cash provided by operating activities.

Statement of Cash Flows-Direct Method

LO 6 Prepare a statement of cash flows using the direct method.

APPENDIX 13B STATEMENT OF CASH FLOWS – DIRECT METHOD

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Illustration 13B-2

LO 6



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Illustration 13B-1


LO 6

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Illustration 13B-1

13-57 LO 6


Illustration 13B-1

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Illustration 13B-4

Cash Receipts from Customers


For Computer Services Company, accounts receivable decreased €10,000.

Illustration 13B-5


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Illustration 13B-6

Cash Payments to Suppliers

Illustration 13B-9

Illustration 13B-7



In 2014, Computer Services Company’s inventory increased €5,000 and cash payments to suppliers were €139,000.

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Illustration 13B-10

Cash Payments for Operating Expenses Cash payments for operating expenses were €115,000.

Illustration 13B-11



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Cash Payments for Income Taxes Cash payments for income taxes were €49,000.



Illustration 13B-12

Illustration 13B-13

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Illustration 13B-16


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Increase in Equipment. (1) Computer Services purchased for cash equipment costing €25,000. And (2) it sold for €4,000 cash equipment costing €8,000, whose book value was €7,000.




Illustration 13B-15

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Increase in Building. From the additional information, the company acquired an office building for €120,000 cash. This is a cash outflow reported in the investing section.




1/1/14 Balance 40,000 Office building 120,000

12/31/14 Balance 160,000

Building

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Increase in Land. Computer Services purchased land of €110,000 by directly exchanging bonds for land.

Significant non-cash investing and financing

transaction.

Increase in Bonds Payable. Bonds Payable increased €110,000. The additional information indicated that Computer Services issued €110,000 of long-term bonds in direct exchange for land.




Significant non-cash investing and financing

transaction.

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Increase in Share Capital - Ordinary. The Share Capital - Ordinary account increased €20,000. The additional information indicated that Computer Services issued ordinary shares for cash.

Increase in Retained Earnings. The €116,000 net increase in Retained Earnings resulted from net income of €145,000 and the declaration and payment of a cash dividend of €29,000.

Financing activity (cash dividend).

Financing activity.




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Illustration 13B-16


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Compare the net change in cash on the Statement of Cash Flows with the change in the cash account reported on the Statement of Financial Position to make sure the amounts agree.

Step 3: Net Change in Cash



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APPENDIX 13C T-ACCOUNT APPROACH

What this means is that the change in cash is equal to the change in all of the other statement of financial position accounts.

Another way to think about this is that if we analyze the changes in all of the non-cash statement of financial position accounts, we will explain the change in the cash account.

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Illustration 13C-1

APPENDIX 13C

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Key Points Companies preparing financial statements under both GAAP and

IFRS must prepare a statement of cash flows as an integral part of the financial statements.

Both IFRS and GAAP require that the statement of cash flows should have three major sections—operating, investing, and financing—along with changes in cash and cash equivalents.

Similar to IFRS, the statement of cash flows can be prepared using either the indirect or direct method under GAAP. Companies choose for the most part to use the indirect method for reporting net cash flows from operating activities.

Another Perspective

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Key Points The definition of cash equivalents used in GAAP is similar to that

used in IFRS. A major difference is that in certain situations, bank overdrafts are considered part of cash and cash equivalents under IFRS (which is not the case in GAAP). Under GAAP, bank overdrafts are classified as financing activities in the statement of cash flows and are reported as liabilities on the statement of financial position.

IFRS requires that non-cash investing and financing activities be excluded from the statement of cash flows. Instead, these non-cash activities should be reported elsewhere. This requirement is interpreted to mean that non-cash investing and financing activities should be disclosed in the notes to the financial statements instead of in the financial statements. Under GAAP, companies may present this information on the face of the statement of cash flows.

Another Perspective

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Key Points One area where there can be substantial differences between IFRS

and GAAP relates to the classification of interest, dividends, and taxes. The following table indicates the differences between the two approaches.

Another Perspective

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Key Points Under IFRS, some companies present the operating section in a

single line item, with a full reconciliation provided in the notes to the financial statements. This presentation is not seen under GAAP.

Similar to IFRS, under GAAP companies must disclose the amount of taxes and interest paid. Under GAAP, companies disclose this in the notes to the financial statements. Under IFRS, some companies disclose this information in the notes, but others provide individual line items on the face of the statement. In order to provide this information on the face of the statement, companies first add back the amount of interest expense and tax expense (similar to adding back depreciation expense) and then further down the statement they subtract the cash amount paid for interest and taxes.

Another Perspective

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Looking to the Future Presently, the FASB and the IASB are involved in a joint project on the presentation and organization of information in the financial statements. One interesting approach, revealed in a published proposal from that project, is that in the future the income statement and statement of financial position (balance sheet) would adopt headings similar to those of the statement of cash flows. That is, the income statement and statement of financial position would be broken into operating, investing, and financing sections.

With respect to the cash flow statement specifically, the notion of cash equivalents will probably not be retained. That is, cash equivalents will not be combined with cash but instead will be reported as a form of highly liquid, low-risk investment. The definition of cash in the existing literature would be retained, and the statement of cash flows would present information on changes in cash only. In addition, the FASB favors presentation of operating cash flows using the direct method only. However, the majority of IASB members express a preference for not requiring use of the direct method of reporting operating cash flows.

Another Perspective

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Under GAAP interest paid can be reported as:

a) only a financing element.

b) a financing element or an investing element.

c) a financing element or an operating element.

d) only an operating element.

GAAP Self-Test Questions

Another Perspective

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IFRS requires that non-cash items:

a) be reported in the section to which they relate, that is, a non-cash investing activity would be reported in the investing section.

b) be disclosed in the notes to the financial statements.

c) do not need to be reported.

d) be treated in a fashion similar to cash equivalents.


Another Perspective

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In the future, it appears likely that:

a) the income statement and statement of financial position (balance sheet) will have headings of operating, investing, and financing, much like the statement of cash flows.

b) cash and cash equivalents will be combined in a single line item.

c) the IASB will not allow companies to use the direct approach to the statement of cash flows.

d) None of the above.


Another Perspective

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